Pump It Up: The Development of Iraq's Oil Reserves

By Vivienne Walt
Monday, December 7, 2009

In the spring of 2003, more than a million people
marched through the streets of cities across Europe and the U.S. to rail
against U.S. plans to invade Iraq and oust Saddam Hussein. Amid the
chants for peace was an angry accusation: the war was merely a grab by
Western companies for Iraq's vast oil reserves.

Nearly seven years on - and after more than
4,600 Americans and tens of thousands of Iraqis have been killed -
Iraq's natural resources are only now emerging as spoils of war. As U.S.
troops prepare to withdraw from the country next year, some of the
world's biggest energy companies, among them ExxonMobil and Royal Dutch
Shell, are racing to lock up multibillion-dollar deals with officials in
Baghdad that will allow them to exploit the country's giant oil fields.
The deals will not only allow Big Oil to return to Iraq for the first
time since Saddam nationalized the industry in 1972. By modernizing a
production system wrecked by conflict and embargoes, Iraq's exports
could also get a huge boost, putting the country's parlous economy on
firmer footing and allowing Iraq to take its place as an oil power
almost equal to Saudi Arabia.

Not just the fortunes of one war-torn country are at
stake. Researchers believe that Iraq's untapped oil reserves total at
least 115 billion barrels - the third largest in the world. When
fully developed, Iraq's oil industry could significantly boost global
crude supplies and even bring down oil prices. Tapping Iraq's oil is an
industry event of historic proportions, says Alex Munton, a Middle East
analyst at global energy consultancy Wood Mackenzie. "There are very few
examples in history you can point to and say, 'A similar thing happened
there,' because there really have not been any," he says. After a flurry
of initial oil field - development deals were completed in
November, Munton said, "Iraq's future has just changed, absolutely."

Until recently, that change looked like it might
never happen. Last summer, Iraq's government hosted an auction for eight
large oil and gas fields at Baghdad's high-end Al-Rashid Hotel. There,
oil executives from the U.S., Europe, Russia, China and South Korea
paraded on stage and dropped their bids into a sealed box, in a ceremony
broadcast live on Iraqi television. It was meant to be grand theater,
but proved a p.r. failure for Baghdad. Just one bid succeeded: it was
submitted by a partnership between Britain's BP and China National
Petroleum Corp. (CNPC) for production rights to southern Iraq's giant
Rumaila field. Other companies abandoned the process after Iraqi
officials refused to pay more than $2 for each barrel produced above a
certain threshold. (Instead of leasing the fields to operators and
receiving royalties for every barrel of oil sold, Iraq is retaining
ownership of production. In essence, the government is employing oil
companies to develop the fields, paying them by the barrel.)

The auction's failure was due in part to the
government's inflexibility. Baghdad is under pressure by Iraq's feisty
oil unions and politicians, who have accused leaders of aiming to sell
the country's riches on the cheap to gain a little short-term relief for
the economy. Oil executives argued they should be paid as much as $3.99
a barrel - nearly double the government offer - because of the
risks involved. Operating in Iraq means investing billions in an
unstable country where foreign oil workers are routinely kidnapped and
insurgents have blown hundreds of holes in pipelines. Rochdi Younsi,
until last month the director of Middle East and Africa for the Eurasia
Group in Washington, told TIME that the auction was "a fiasco and
embarrassment," saying that the government "thought oil companies would
do absolutely anything to get into Iraq."

The government may have been right all along. After
months of sticking to their demands, oil companies now are agreeing to
Iraq's $2-a-barrel offer. In mid-November, Italian oil executives from
ENI flew to Baghdad to sign a deal on Zubair, a southern Iraq field with
about 4.1 billion barrels of reserves. ENI plans to pump about 1.1
million barrels a day from Zubair in partnership with California-based
Occidental Petroleum and South Korea's Kogas. ENI was quickly followed
by ExxonMobil and Royal Dutch Shell, which agreed to produce about 2.3
million barrels a day in another giant field called West Qurna. Combined
with BP-CNPC's anticipated output from Rumaila, "those three fields
alone would be about 6% of total oil production in the world" when
output targets are reached, says Munton, the Wood Mackenzie analyst.

The catalyst for the flurry of agreements appears to
be the BP-CNPC deal, Iraq's first international oil contract in nearly
four decades. The British and Chinese companies won the right to drill
for 20 years in what is believed to be one of the world's four largest
fields with potential reserves of about 65 billion barrels. Though it
will earn only $2 a barrel, BP says it aims to keep expenses down by
using low-cost Chinese labor and equipment. The group promised Iraq's
government that it will nearly triple the field's output from 1 million
barrels a day to about 2.8 million barrels a day in just seven years.
"We see this as the beginning of a long-term relationship," BP's chief
executive Tony Hayward said in a statement.

For oil companies, establishing similar relationships
with Baghdad could prove crucial, and highly profitable. As oil supplies
dwindle in places like the North Sea and Gabon, companies are desperate
to book new reserves - and Iraq, which unlike Kuwait or Saudi
Arabia is incapable of producing its oil without foreign know-how and
investment, is up for grabs. Unlike huge new finds off Mexico, Brazil
and West Africa, many Iraqi fields were mapped years ago - some by
the same companies now negotiating new contracts - and so will not
require lengthy exploration before pumping can begin.

Fresh from a trip to Baghdad, Yves-Louis
Darricarrère, who heads global exploration and production for the
French energy giant Total, told TIME in early November that oil
executives all feared being left out of the rush. "Iraq is extremely
important for the industry and for world supply," he said. Even though
Total dropped its bid in June for one of Iraq's fields, it is now
considering several others on offer in a second round of bids, which
Iraq's government has scheduled for mid-December; Iraqi oil officials
say they expect about 45 companies to compete for 15 fields. Says
Darricarrère: "It is difficult for any major oil company not to
be in Iraq."

But being there won't be easy, either, due to
daunting technical and other challenges. Iraq's oil industry has limped
along for years on creaking old equipment, patchwork pipeline networks
and decayed, rusted port facilities; Saddam-era sanctions largely
prevented the industry from upgrading to state-of-the-art equipment. The
country produces just 2.5 million barrels a day, down from 2.8 million
barrels before the U.S. invasion and a sharp drop from its high of 3.7
million barrels in 1979, when Saddam boosted production to finance his
calamitous war with neighboring Iran. A government adviser recently told
Britain's Independent newspaper that only about one-third of the
1,400 wells in southern Iraq are functioning. Oil Minister Hussein
Shahrastani estimates it will cost about $50 billion to upgrade
infrastructure needed to produce Iraq's target of 6 million barrels a
day by 2017. "Iraq's oil industry is in a dire state," says Samuel
Ciszuk, Middle East energy analyst for the consultancy firm IHS Global
Insight in London. "Decades of war, brain drain, political instability
and underinvestment have all depleted what was there." When foreign oil
companies finally start working Iraq's fields, they will face a critical
shortage of local engineers, geologists, managers and almost everyone
else they need, since previous generations of professionals have left
the country.

While stability is returning, this relative peace is
fragile. Iraqi officials and oil executives have rushed to sign
contracts before national elections scheduled for January, since no one
knows whether the current government will remain in power. Shahrastani
is under fire from opposition politicians, who are complaining of
widespread corruption and mismanagement in his ministry. In addition,
oil contracts signed during the past five years with the Kurdistan
Regional Government, whose three semiautonomous Iraqi provinces until
recently exported about 100,000 barrels of oil a day, have been declared
illegal by Baghdad, forcing Kurdish leaders to halt exports in
October.

Indeed, battles over how to carve up Iraq's oil
revenues between the country's bitterly divided ethnic groups have
stopped parliament from signing a national hydrocarbon law originally
drafted in 2006. After previously insisting that they would not do
business in Iraq without a legal framework governing central issues such
as revenue-sharing, oil executives now are resigned to the fact that it
may be years before a law is forthcoming.

Neither companies nor government officials want to
wait any longer to kick-start production. The Iraqi people are impatient
for economic relief, and since more than 90% of Iraq's budget comes from
oil revenues, nothing seems to offer more hope than the arrival of Big
Oil. "We still have a long way to go to build the country," says Ahmeh
Jasim, 56, a real estate agent in Baghdad. "Without these companies it
is very hard to have a proper oil sector." For most Iraqis, the drilling
cannot begin soon enough.